Every silver lining has a cloud

The Government estimates that over the next 10 years approximately 600,000 people will cease smoking as a result of the new ban on smoking in public places. However, there is an unexpected cost to this improvement in the nations’ health as the resulting reduction in smoking related deaths will distort mortality tables used to calculate pensions. This will mean a reduction in the annuity available for those with money purchase pension pots and an increase in the cost of providing pensions for those providing final salary pension benefits.

This news comes hot on the heels of evidence that we are, on average, living a lot longer. Recent figures looking at the four year period to 2002 and replacing figures for the four year period to 1994 showed mortality rates around 30% lower for both males and females in their late 60’s, the equivalent of an improvement rate of over 4% per year.

This information comes hot on the heals of similar findings from the Pensions Policy Institute who’s research director, Chris Curry commented that “Even unskilled manual workers, who are likely to have the lowest life expectancy, can still expect to live 16 years after state pension age.”

A study conducted by Stanford University in California has suggested that by 2050 the population could have to work to the grand age of 85!! Based upon their calculations currently we have 1.5 pensioners for every five employees, but by 2050 that figure will rise to four pensioners for every five workers. The reports author suggested that “We have seen a doubling of human lifespan in the last century………Even without anti-aging strategies, retirement ages will reach 75 in a couple of decades.”

So whilst it’s good news that we’re all expected to live longer the associated bad news is that having to provide pension benefits for longer means a strain on already over stretched final salary arrangements or significant reductions in the annuity rates available to those securing pensions from money purchase funds.

Experience would suggest that final salary schemes tend only to review their mortality assumptions when completing their triennial valuations rather than on a more frequent basis. Such an approach is to some extent inadvertently supported by FRS17, which does not require mortality assumptions to be disclosed. With full disclosure of pension liabilities in company accounts under FRS17 now upon us and given the likely impact of these mortality improvements on scheme liabilities, this really is something which should be addressed in the short term.

This could be something of a ‘double whammy’. Not only will many schemes not have fully incorporated previous mortality improvements but they will need to incorporate these further improvements just at a time when disclosing the position more fully in company accounts becomes mandatory. Many scheme sponsors are likely to be shocked by the potential impact to their funding position and the likely increased level of contributions required to plug an even larger scheme deficit. We are indeed already witnessing a worsening of many schemes funding position over recent months as mortality improvements and falling bond yields outweigh significant increases in equity values.

Recent NAPF statistics suggest that 70% of existing private sector schemes are now closed to new members with around 10% closed to all further accruals. We can only see this news putting further pressure on schemes and forcing further closures, especially when viewed in conjunction with the new risk based PPF levy and scheme specific funding.

Scheme sponsors and trustees need to be aware of the impact of these improvements in mortality on their scheme as soon as possible to allow them to take informed decisions. Companies will need to take a much more realistic approach to funding the pension promises already made as well as considering how practical it is for them to be able to continue to accrue additional liabilities under such arrangements.

David Davison is a Director at Spence & Partners, independent actuaries and consultants.